Excerpt from fund manager John Hussman’s weekly essay on the US market:
While profit margins are at record highs, disposable income as a percentage of GDP is closing in on record lows. The disposable income share was slightly lower in 1980 than it is today. Of course, in 1980, unemployment exceeded 7%, so it was possible to squeeze wage earners to a slightly lower share, but even that was short-lived, as labor compensation grew and profits fell in the next few years.
The effects of profit margins and employment conditions on subsequent earnings growth are important. Once profits become a large share of GDP and unemployment falls to relatively low levels, earnings growth is typically disappointing over the following 2-3 years. In contrast, when profits are a small share of GDP and unemployment is high, subsequent earnings growth tends to be well above-average.
To put some numbers on this, since 1963, when the profit share of GDP has been greater than 6% and the unemployment rate has been less than 6%, profits have crawled along at just 2.13% annually, on average, over the subsequent 3-year period. In contrast, when the profit share of GDP has been smaller than 6% and the unemployment rate has been above 6%, profits have enjoyed an average growth rate of 9.94% over the subsequent 3-year period.
With corporate profits pushing above 9% of GDP, the unemployment rate at just 4.6%, and S&P 500 earnings at the top of their 6% long-term growth channel, investors should not be at all surprised to see “surprising” wage inflation, accompanied by disappointing profit margins and weak earnings growth in the next few years.